Politics, Economics and the Coming Market Correction

Politics, Economics and the Coming Market Correction

Dow Jones 1929 Crash and Bear Market

Source: www.macrotrends.net. “Down Jones – 1929 Crash and Bear Market”

With the contentious election and the protests surrounding the inauguration behind us, many of us assumed we’d be well past the media-fueled vitriol which appears focused on driving a wedge through the country.  We have heard so much about what President Trump has accomplished (or failed to accomplish) in his first 100 days, while many do not even realize he has over 1,300 days left in his term. Frequently, I have heard learned people comment about how this is the most derisive political environment in our history.  Take for example this recent quote regarding the election outcome I recently came across:

“Glad? I should say we are!  Why, who wouldn’t be?  Everybody’s glad!  But of course, you people over there, you wouldn’t know how the country feels-all your news is slanted!”

This sounds like it could have been lifted from yesterday’s headlines, right?  In fact, this excerpt was taken from the 2006 book, My Life in France by Julia Child, recalling a conversation she had with her father following the election of Dwight D. Eisenhower in 1952 (a fascinating book for those of us who like to eat!)  Those of you who have read this newsletter in the past may recall my examples of the scandalous political ads of the late 1700’s, and the famous duel of 1804, in which the sitting Vice President Aaron Burr killed political rival Alexander Hamilton.  By comparison, one could argue that today’s political climate is extremely tolerant.  The bottom line is this: the political discontent and rivalry is what it is, and it is pretty much always this way.  In the past 241 years, political rivalries have not stopped the economic advancement of America, nor will they today.  Thus, the idea of staying out of the market when your party is not in power is not a useful one, regardless of which side of the aisle you are on.

Waiting for "Your Team" to Win Before You Invest?

Source: Oppenheimer Funds, Bloomberg, 12/31/15

.Despite our derisiveness, the markets march on:

S&P 500: +6.1%                      EAFE:          +6.5%              Barclay’s Aggregate Bond:  +2.7%

Despite the cries of gloom and destruction, the market continues to churn out positive returns.  In fact, voter satisfaction with our administration has very little correlation to market returns.  In the graph below, the blue line represents presidential approval ratings going back to 1960.  The grey mountain chart indicates the values of the Dow Jones Industrial Average over that time.  As you can see, particularly with our two most immediate past presidents, significant and sustained drops in their popularity did nothing to diminish the market’s ability to deliver positive results over time.  No matter how unhappy you are with the political power running the show, you will still need goods and services; things such as toilet paper, cell phones, cars and food.  Life will march on whether you are happy or not.  In short, hating your government is not an investment strategy, or at least not a very good one:

Approval Ratings and Markets Don't Always Move in the Same Direction

Source: Oppenheimer Funds, Bloomberg, 12/31/15.

So, Now What?  

A common refrain I hear from prospective investors revolves around the concern that the market has come too far, too fast, and that they have missed the opportunity to get in.  Indeed, a quick glance at this chart is enough to keep anyone from seriously considering new investments into stocks:P4

The idea that “stocks are at all-time highs” is keeping many investors from making prudent allocations to stocks.  The temptation to “wait for a correction” to get back in is an alluring idea, but frankly, the data does not support that idea.  Yes, it would be helpful to be able to side step the worst days in the market (as a 1994 University of Michigan study shows here), but the fact of the matter is that timing the market successfully has so far proven to be an impossible task…and it does not matter much anyway.  Indeed, a recent study conducted by the American Funds Group compared the result of two hypothetical investors over the 20-year period ending 12/31/2015.  One investor had the good fortune to invest $10,000 annually on the lowest market point of each year, and the other had the misfortune of investing at the market high each year.  Not surprisingly, the investor with perfect market timing generated a better result, turning the $200,000 investment into $486,359. However, the poor soul with the terrible timing did not do so bad either, turning his $200,000 into $393,868.  The point is, significant and important returns can be missed while trying to time the market, and if achieving your goals requires you to grow your assets over time, you will be best served to develop a prudent investment plan and stick to it.  Furthermore, the perspective of time is very important when considering your investment decisions.  Remember that scary chart from above?   Here is the same chart, over a more significant time period:P5

In the context of a longer time period, all of a sudden, a chart which looked like it had nowhere to go but down now looks like it just may be on the verge of another extended run.  Only time will tell what happens over the long term, but the data weighs heavily in favor of investing instead of attempting to time market swings.

Economics “Trump” Politics

Ignoring the media and looking at the numbers, 2017 is shaping up to be yet another good year for the U.S. economy.  Despite what we hear, corporate earnings, as measured by the S&P 500, had posted another strong year in 2016, and analyst expectations for the coming year are the most positive they have been in some time.P6

Even energy sector earnings, undeniably one of the most embattled sectors of the S&P for the last several years, have posted marked improvements and are seeing stronger expectations for 2017:

Energy sector earnings

 Source: Compustat, FactSet, Standard & Poor’s, J.P. Morgan Asset Management.

Light vehicle sales remain strong, manufacturing and trade inventories have declined in the face of stronger demand, housing starts (while still below the long-term average) continue to improve, and capital goods orders have shown a recent uptick as confidence in economic growth continues to improve.

Next Up: The Coming Market Correction

I am often asked my thoughts on what is going to happen next in the market.  Rather than trot out some of the familiar adages about it going up, down or staying the same, I thought I would break the mold with a bold prediction:  I believe the next major move for the market will be a correction.  It will likely happen this year, and it will likely be a drop of about -14.1%.

What?

I know!  I just got done explaining how positive everything looks, and encouraged you to make sure you have a prudent allocation to stocks, and not to hold off investing while you wait for a correction.  How can I be predicting such a big drop?  The fact is, it is pretty easy to be confident in this prediction.  Why?  The answer is in the chart below:S&P 500 Intra-year declines vs. calendar year returns

This chart outlines intra-year market performance of the S&P 500 each year going back to 1980.  The gray bar indicates where the market ended for the year.  Accordingly, 1980 (the very left bar) ended with the market posting a gain of approximately 26%.  See the red dot with the “-17%” just below?  That signifies the intra-year drop that year; somewhere along the path to the 26% gain was a jaw-dropping 17% decline, which no doubt shook investors’ confidence, and caused many to abandon their strategy and get out of the market.  A few things stand out about this chart:  first, a quick glance shows you that there are a lot more gray bars ending the year in positive territory than in the negative, second, there are lots of red dots.  In fact, there is one in every year.  Averaging all those red dots, you find that over this 37-year period, the average decline was 14.1%.  Our last meaningful correction was in late January 2016 (Remember that one?  I do – it was unpleasant, particularly following a weak market in 2015.)  Indeed, in Tony Robbin’s new book on investing, Unshakable, he rightly points out that for whatever period you invest, you should expect to experience as many corrections as you do birthdays… they essentially happen every single year.  The other takeaway from this chart is that at no time does it retrospectively appear logical or profitable to sell in these corrections, as the market has always recovered.  Though it may take longer than we wish, the concept discussed above remains true: you are better off in the market with a prudent allocation to stocks than you are out of it.

But What If This Time Is Different?

I can guarantee you that according to the media, this time will indeed be different.  First, keep in mind with a Dow at almost 21,000, a drop of 14% will equate to an almost 3,000-point drop.  You will hear things like “the largest point drop in history”, “the single biggest one-day decline ever”, and other such commentary.  While all that may be true, keep in mind that we are thinking in percentage terms, not point terms – of course these will be the biggest point drops ever – but the percentage drops will be in line with what is normal.  From our perspective, unless there is some significant macro-economic change we are not currently expecting, our recommendation will not be changing in this type of correction, except to perhaps explore a little bargain hunting if the opportunities present themselves.

This time of year, I often refer to Warren Buffet’s annual letter to shareholders for pearls of wisdom regarding investing.  You can find the complete letter here.  I thought Mr. Buffet summarized things beautifully in the excerpt below:

“One word sums up our country’s achievements: miraculous. From a standing start 240 years ago – a span of time less than triple my days on earth – Americans have combined human ingenuity, a market system, a tide of talented and ambitious immigrants, and the rule of law to deliver abundance beyond any dreams of our forefathers. You need not be an economist to understand how well our system has worked. Just look around you. See the 75 million owner-occupied homes, the bountiful farmland, the 260 million vehicles, the hyper-productive factories, the great medical centers, the talent-filled universities, you name it – they all represent a net gain for Americans from the barren lands, primitive structures and meager output of 1776. Starting from scratch, America has amassed wealth totaling $90 trillion… This economic creation will deliver increasing wealth to our progeny far into the future. Yes, the build-up of wealth will be interrupted for short periods from time to time. It will not, however, be stopped. I’ll repeat what I’ve both said in the past and expect to say in future years: Babies born in America today are the luckiest crop in history…American business – and consequently a basket of stocks – is virtually certain to be worth far more in the years ahead. Innovation, productivity gains, entrepreneurial spirit and an abundance of capital will see to that. Ever-present naysayers may prosper by marketing their gloomy forecasts. But heaven help them if they act on the nonsense they peddle.”

We look forward to being of continuing service to you and your families!

Plan Wisely-Invest Confidently-Enjoy Life!

Composed and Edited by:  the Cascade Team